The regular rebalance cadence for portfolios is being amended to capture market dynamics that are playing out sooner than expected. As a result, this rebalance was brought forward one month to June. The trigger for the early rebalance is the relatively successful reopening of economies globally to date. As the market continues to shift to adjust to the rapidly changing atmosphere, we will continue to monitor portfolios and re-optimize as needed.
Key Takeaways
The US has not seen the type of surge in virus cases that some have expected and that could once again threaten the capacity of the healthcare system. We believe it makes sense for portfolios to lean into equity sectors that are more reliant on traditional cyclical activity and that have thus far lagged in the recovery trade, giving us a more targeted opportunity to potentially benefit from the upside of improving sentiment and business prospects driven by reopening economies.
A rally in beaten down, ‘junkier’ sectors of the market would provide a powerful boost to returns for the few investors who remain invested in those sectors. The recent resurgence in sectors with more traditional value characteristics and lower quality capitalizations has room to run in our view. These heavily beaten down sectors are sensitive to a return to growth in the economy, which we believe will be well underway by fall. Structural growth themes remain in the portfolio. The new positions are a barbell strategy between these technology-oriented positions and cyclically sensitive value, financial and small cap sectors.
Over the long run, we believe technology and growth-oriented segments of the market can continue to outperform in a world of significant policy stimulus, low rates, and low inflation. Moreover, the lack of an effective vaccine and widely available therapeutics for the virus keeps an ‘all-clear’ signal elusive and somewhere out on the horizon. While current equity market levels are not written in stone, and the tape could move lower, the portfolios are positioned anticipating the year closes with equities higher, recognizing there may be bumps along the way. To account for this, portfolios are shifting treasury duration and positioning within credit.
Trade Rationale
Asset Allocation: We continue leaning into risk across portfolios, adding to equities cautiously, targeting beaten down value and cyclically oriented exposures and adjusting our regional bets. These moves are somewhat offset with modest increases in duration within our fixed income sleeves in order to maintain a risk ballast.
US Equities: We maintain but reduce our long-standing overweight to US equities. Some large cap exposures are sold to fund small cap, financial services sector, and value factor purchases. Large cap growth stocks led the market rally in the two months since the March lows, but as markets stabilize and risk appetite recovers, we believe those names most beaten down have relatively more room-to-run in the near-to-intermediate-term.
International Developed Market Equities: Europe has recently moved closer to releasing a much-needed fiscal stimulus package. Consistent with our theme of adding to names that have thus far lagged in the recovery, we add to broad domestic market equities, which have a more mid- cap/value tilt than our existing growth-oriented domestic market exposure.
Emerging Market (EM) Equities: We reduce EM equities to benchmark weight, giving us the budget to fund increases elsewhere in the portfolio. We are constructive on EM from a valuation perspective, but with Latin America now the epicenter of the pandemic, we find the position less attractive given the current Covid-19-related risks.
Fixed Income: Although we move further underweight bonds relative to stocks, by adding to treasuries and extending duration slightly across most risk-profiles we position fixed income in the event equities continue to experience bumps along the way. In our fixed income-heavy portfolios we express a more US- focused, pro-cyclical stance by purchasing US high-yield bonds, funding from short term and broad investment grade bonds. Conservative portfolios are reducing their EM bond exposures to fund some of the high yield bond purchase. We improve the relative resilience of our equity-heavy portfolios by trimming credit and adding to US government bonds.
